Politics, World

War turns Russia into recession, weakens growth potential, says expert

International sanctions driven capital outflow, GDP contraction, collapsing ruble; Russia's war-period economy turns into recession

Tuba Sahin  | 24.02.2023 - Update : 25.02.2023
War turns Russia into recession, weakens growth potential, says expert


Russian economy entered a recession as lower real wages cut consumer expenditure and investment was smashed by international sanctions as a result of its war on Ukraine, and it is not likely to pick up a strong pace soon, according to an expert.

Speaking exclusively to Anadolu on the first anniversary of the launch of the war, Heli Simola, senior economist at the Bank of Finland, stressed that Russia's economic outlook severely deteriorated last year and its GDP is expected to decline slightly further this year.

"Growth potential is weak also in the longer term. Even before the war, Russia's GDP growth potential was quite low for a country of Russia's income level, about 1.5% per year," she added.

According to a preliminary estimate from the statistics agency Rosstat, the Russian economy contracted by 2.1% in 2022, with the gross domestic product GDP reaching 151.45 trillion rubles (some $2 trillion).

According to the International Monetary Fund forecast in January, the Russian economy was projected to grow 0.3% this year and 2.1% next year.

The World Bank forecasted the Russian economy to contract by 3.3% this year as EU oil embargos are fully implemented and natural gas exports are reduced by Russia's shutoff of deliveries to the EU via the Nord Stream 1 pipeline.

The growth is estimated to resume next year at 1.6%, with a rise in consumption and a rebound in exports as Russia re-orientates its trading ties, according to the World Bank.

In the long term, Russia's growth potential is likely reduced by the war and its repercussions as the technology transfer will likely be limited; therefore, productivity growth will slow, fixed investment will be discouraged and emigration will drain human capital, according to the World Bank.

"Russian economy posted a record capital outflow of $220 billion in 2022 amid the western sanctions," Simola said.

Western nations have imposed sanctions on Russia and its ally Belarus over the war in Ukraine with the aim of pressuring Russia to end hostilities by reducing the Kremlin's capacity to finance the war and restricting its military industry's access to technology.

Financial sanctions have frozen about half of Russia's foreign exchange reserves (including a large part of Russia's oil fund liquid assets) and substantially restricted Russia's access to foreign financing, leaving the country more susceptible to external shocks.

Prominent Russian lenders have been cut out of the global financial system and hundreds of companies around the world have announced a suspension of operations and withdrawal from Russia.

The Russian ruble has weakened 7.60% against the US dollar since the start of the war on Feb. 24, 2022, hovering below 75 as of Feb 2022 amid weak foreign currency inflows to the economy.

The ruble surprised the world after it bounced back from the West's initial sanctions that sunk it to lows of 150 to the US dollar in early March 2022. By end-January, it gained ground to about 50.1006 -- its strongest level since May 2015.

Russia's central bank held its key interest rate steady at 7.5% in Feb. 2023, for the third consecutive meeting, as inflation continued to ease.

In Sept. 2022, the rate was cut by 50 basis points, meaning that the key rate has been lowered by 1,250 basis points, or 12.5 percentage points, since Feb. 2022, when the bank hiked the key interest rate from 9.5% to 20% in a dramatic move amid sanctions due to the war.

In January, Russia's annual consumer inflation rate fell to nearly a year low of 11.8% after hitting a two-decade high of 17.83% in April 2022, according to the latest data by the Federal State Statistics Service (Rosstat).

Lower energy sales hit the ruble despite intervention by the Russian Central Bank, which has been selling an average of 8.9 billion ruble worth of foreign currency per day since January to offset capital inflows.

Since the start of the Ukraine war nearly a year ago, the EU has frozen €21.5 billion ($23 billion) in Russian assets, EU Commissioner for Justice Didier Reynders announced last week.

Simola highlighted that restrictions on imports from Russia had a limited impact last year due to long transition periods and the shifting of exports to new markets.

The EU import restrictions, along with the EU and G7 price cap mechanism on Russia's crude oil, entered into force in December 2022 and on petroleum products in February 2023, she recalled.

EU's move aimed at cutting Russia's revenue and its supplies by the sea while ensuring stable global energy markets, the European Commission head explained previously.

While the country's oil exports to the EU declined to some extent last year, its exports diverted at discounted prices to purchasers outside Europe, such as India and China, Simola said.

"Latest data implies that after the oil sanctions were implemented, Russia's export and tax revenues from oil have declined substantially. In January 2023, Russia's federal budget revenue from oil and gas declined 46% from the year before," she added.

Russia's total imports dropped 20% year-on-year in December 2022, with technology goods purchase diving 30% as restrictions on exports are focused on this sector, Simola said, citing data from Russia's trading partners.

On the other hand, its inbound shipments from some countries such as China, Turkey and Kazakhstan have increased in the same period.

Thus, output has substantially declined in such Russian industries that are dependent on imports and foreign companies that have left the country, Simola noted, explaining: "For example, the output of passenger cars was down 67%, excavators 53% and television receivers 36% in 2022."

Russia's demographic development is further weakened by war casualties and increased emigration due to the war, Simola added.

Simola underlined that Kremlin's spending is focused on war expenditure instead of productive investment that would support economic growth.

"Russia's productivity has long been weak. Loss of access to cutting-edge global technologies and increasing state involvement with the focus on war economy are weighing further on the development of Russia's productivity," she noted.

Russia's unemployment rate decreased to a record low of 3.7% in December 2022, in line with the Central Bank's statement that the was triggered labor shortages and reduced the capacity of the Russian economy.

The number of jobless people rose by 30,000 from a month earlier to 2.8 million people as of the end-2022.

While it is very difficult to evaluate the costs of the war, Simola said Russia had to substantially increase military spending, which is away from more useful purposes for public spendings, like education and healthcare.

"Russia is set to lose a substantial amount of export revenue and foreign investment. The war has caused GDP losses for Russia and made Russia's economic prospects much gloomier for years."

In February 2022, the Russian Finance Ministry obliged Russian exporters to sell 80% of their foreign exchange earnings after Western sanctions froze half of the Russian Central Bank's overseas reserves of foreign currency in response to the war in Ukraine.

That ratio had been reduced to 50% in May last year.

In February 2023, roughly a year after the obligation was introduced to fend off the effects of Western sanctions, some Russian exporters will no longer have to sell their foreign currency earnings, according to a decree by President Vladimir Putin.

Russia's budget revenues from the oil and gas industry grew 28% annually in 2022, Russia's deputy prime minister announced. That increase amounts to 2.5 trillion Russian rubles ($36.5 billion), Alexander Novak said.

Russia's oil production rose 2% last year to 535 million tons, while oil exports increased 7% despite Western sanctions.

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